Monday, February 16, 2009

Shandong Ag Bank Opens Spigot

In January, the Agricultural Bank of China (ABC) finally became a share-holding company, the last of China's big-4 state-owned banks to do so. It took years to resolve internal problems in ABC to get it ready for the listing. Historically, ABC was made responsible for rural lending when market reforms were implemented in the 1980s. Bank reforms in the 1990s spun off ABC's policy functions (i.e. grain and cotton procurement financing) into a newly-created Agricultural Development Bank of China and ABC was freed up to become a commercial bank. In recent years it has pursued the more promising urban market and most of their business is now urban. You can see ABC branches and ATMs all over Chinese cities.

ABC has a pitiful track record in lending. About a quarter of the loans on its books were nonperforming as of last year (and that's with a generous classification.) Over $100 billion of bad loans were taken off its books and dumped into China's version of a "bad bank" to get ABC ready for its listing. The Central Huijin Investment Co. fund pumped $19 billion cash into ABC--this is cash from China's mountain of foreign exchange reserves earned by China's exports to Wal-Mart et al. (OK, so $100 billion is now pocket change since we're throwing around trillion-dollar bailouts, but we're talking about a country--China--where most people earn about $5 a day.)

ABC was not able to shirk off all its rural lending responsibilities. Apparently, it is still expected to make loans to support government-directed agricultural development plans. Some reports said this was one of the hang-ups in getting ABC's reform plans in place--they weren't allowed to abandon rural business.

Shandong Province's ABC branch has announced a plan to increase loans to county (i.e. rural) economies by 21 billion yuan (over $3 billion). The plan includes funding for rural infrastructure, public welfare and social services. A priority is to increase loans to "dragon head" enterprises that are "pillars" and "backbones" of the rural economy to advance "agricultural industrialization." It plans to increase "micro-loans" to rural households by 4.8 billion yuan.

We're very conscious of the dysfunctional financial system in the U.S. now and we're even getting lectures from Premier Wen Jiabao on this. But China's financial system is no better. Banks still lend according to official directives.

What happens is this: provinces and counties around China decide they want to build up an industrialized corn sector (as an example). They each tell the banks to lend to some starch processing company which gears up production, buying up millions of tons of corn to turn into starch, sugars, citric acid, lysine and feed products. After a while, the companies discover the market is saturated, so they start exporting in a big way, much to the consternation of factories in North America and Europe. Chinese products come in at half the price of U.S. or French products, and antidumping suits are brought. Lawyers are hired, tariffs are raised for a while, and the Chinese companies figure out how to keep selling. Industries are wiped out and corn is wasted by pumping out loss-making products. Chinese companies are still losing money and some close and default on the loans.

These days it's fashionable to think that it's OK for the government to tell banks how to run their business, but history shows that this mode of operation leaves even bigger messes to clean up. China's experience from the 1950s through the mid-1990s is exhibit A. China's banks' problems are hard to discern when lending grows 15-20% a year, but they may spin out of control eventually. Press cntl-alt-del before it's too late.